Abstract

Risk Management of German Non-Financial Corporations

Ali Fatemi and Martin Glaum

DePaul University, Chicago
Justus-Liebig-Universität Gießen

Corporate risk management has attracted a lot of attention in recent years. There are several reasons for this: the increased volatility of financial markets, the development of new risk management instruments and techniques, the spectacular losses of some firms in the markets for financial derivatives, and the increasing attention given to the firms’ risk management activities by investors, analysts and supervisory authorities. Several studies have attempted to provide insights into the practice of corporate risk management over recent years (e.g., see Bodnar, Hayt and Marston 1995, 1996, 1998; Berkman, Bradbury and Magan 1997; Howton and Perfect 1998; Bodnar and Gebhardt 1998). Others investigate into the determinants of corporate hedging policies (see Nance, Smith and Smithson 1993; Mian 1996; Geczy, Minton, and Schrand 1997). However, these studies mostly focus on selective issues only and do not, therefore, provide a comprehensive picture of corporate risk management practices. This is particularly problematic with respect to the studies on the determinants of corporate hedging policies. They attempt to test the validity of alternative theories of coporate hedging by comparing the characteristics of firms using financial derivatives with those of firms that do not use them. However, derivatives can be used to create exposure to financial risks as well as to hedge risks. Characterizing all firms which use derivatives unambiguously as "hedgers" without further knowledge about their risk management strategies may lead to inconclusive or biased results. Indeed, as the present paper reveals, firms in reality follow very diverse and complex risk management practices. Clearly it is desirable to base tests of corporate hedging theories on a more comprehensive and complete set of data.

The present paper is such an attempt. We survey all non-financial German firms listed on the Frankfurt Stock Exchange with a minimum sales volume of DM 400 million in the financial year 1997. An extensive questionnaire was mailed to each of the 153 firms that met the selection criteria. Responses received from 74 of these firms form the basis of our study. In the first part of the paper, we provide an overview over the results of the survey. We report on the firms‘ risk management objectives, on the organization of the firms financial operations, on their approaches towards exchange rate risk and interest rate risk management, and on their use of financial derivatives. For instance, we find that an overwhelming majority of 90% of our respondents do use derivative instruments. At the same time, however, only a minority of 22% of the participating firms indicate that they immediately hedge all of their exchange risk exposure; more than half of the firms base their hedging decisions, at least to some part, on the use of foreign exchange rate forecasts. With respect to interest rate risk, only 3% (two firms) indicate that they immediately hedge all their exposure; a clear majority of about 68% indicate that they use forecasts of interest rates to decide whether to cover their interest rate exposure.

In the second part of the paper, we will investigate the determinants of the German firms‘ hedging practices by relating our findings to alternative theories of corporate hedging. Previous studies have found that agency problems, the probability of financial distress and firm size help to explain why firms‘ propensity to hedge. Mixed results were obtained with respect to the coordination of investment and financing and to taxation effects. However, as was pointed out above, the methodology of previous empirical studies which typcially categorize firms as "hedgers" and "non-hedgers" by looking at whether or not they use derivative financial instruments may lead to biased results. In order to overcome such problems, our tests will be based on more detailled information about the firms‘ exchange rate risk and interest rate risk management strategies.